What are Debt Based Funds?
Debt Based Mutual Funds mainly invest in a mix of Debt or Fixed Income securities such as Treasury Bills, Government Securities, Corporate Bonds, Money Market instruments and other debt securities of different time horizons. Generally, debt securities have a fixed maturity date and pay a fixed rate of Interest.
When should you invest in a Debt based Mutual Fund?
- When your goals are less than 5 years away; or
- Your growth objectives will be met with a lower (8-9%) rate of return; or
- You are not comfortable with volatility and willing to adjust your growth expectations accordingly.
Fixed Deposits have been considered as the safest mode of investment since ages in India. However, with the emergence of SEBI regulations in 1996, risk on investment in Mutual Fund have decreased greatly.
Let us have an Analysis of the Pros and Cons of investment in a Fixed Deposit and a Debt Based Fund.
- MORE EARNINGS IN DEBT FUNDS OVER FD.
The basic difference when it comes to Taxation in a Fixed Deposit and Debt Funds are that Interest on FD are taxed as per the Income Tax slab under which the individual falls, whereas long term earnings under a Debt fund are subject to indexation and the net earning is taxed at flat 20%.
What hurts an FD investor even more is that they have to pay taxes on accrued interest every year (even if you haven’t actually received it in your hands) and therefore the amount of money which compounds is less!
Let us look at example, where the FD is earning an interest @7.5% and the Fund is earning an interest @ 9% on average, and the Post tax returns can be different as follows:
Note: The Redemption value of Debt funds are the Post Tax Returns. While calculating the capital gain tax, the indexation effect has been duly considered and the investment have been deemed to be invested during the period from FY 2012-13 to FY 2017-18.
Rates so taken are the average rates as prevailing in the market.
Analysis of the Table: The above table clearly shows the earnings in a Debt Fund and earnings in a Fixed Deposit of an individual under different tax slabs. If we compare the earnings in a FD and earning in a Debt fund of an individual who falls in the category of 30% tax, the difference in earnings for a span of 5 years is Rs.211,351 i.e. a whopping 20% and that too after keeping your capital intact and safe.
Now imagine, if the same investment is kept secured for period of ten years, the difference in earnings would sum up to Rs. 644,300.
2: SAFETY OF CAPITAL IS ALMOST THE SAME.
To understand how safe your money is, you need to look at the credit rating of the instrument. This is given by Independent Credit rating agencies using the below scale:
Most Fixed Deposits are AAA rated implying very high safety of capital. However, they are assumed to be safe only up to Rs.1 Lakh since they are insured under the Deposit Insurance and Credit Guarantee Scheme of India.
Debt funds are not themselves rated but their safety can be deduced from the portfolio they invest in – typically sovereign to AA. With careful analysis and under proper guidance of an Advisor, you can pick debt funds whose portfolio has a combined credit risk almost at par with FDs.
3: FDs OFFER ASSURED RETURNS BUT DEBT FUNDS OFFER HIGHER POST-TAX RETURNS
When you place an FD, the interest rate gets locked. It’s currently 6.75 to 8% for FDs above a year. You can accurately predict the amount of money you will have at the time of maturity even before you start the FD.
Debt funds provide 8.5 to 11% returns when you look at the historical debt funds’ performance. However, there is volatility when it comes to interest rates in a Debt Fund, which can be smartly avoided after proper research and guidance of an Advisor.
4: DEBT FUNDS PROVIDE BETTER LIQUIDITY OR EASY ACCESS TO YOUR MONEY.
If you need your money back before the maturity of the FD, you will receive a lower rate of interest and also pay a penalty. Some banks allow you to break your FD in part but most require you to withdraw the whole amount. If you have INR 1 lakh deposit, but you only want INR 20,000, you have to break the entire FD.
Interest Rate on premature withdrawal = Interest Rate applicable for actual period of FD as per the rates prevalent at the time of investment – 1%. The penalty for withdrawing is 0-1.5% of the invested amount viz. Rs 0-1500 for a one lakh deposit.
With debt funds, you have full liquidity for your investments. You can withdraw any amount you wish to from your total debt fund value whenever you want. The money comes into your bank account in 3-4 working days. The return you get is the amount earned by the fund during the period you were invested. There is no complex formula.
Some debt funds will charge you an exit load if you withdraw within a certain period of time. This is usually small (0.25% – 0.5%) and only for periods less than a year.
5 BURDEN OF TAX-RELATED PAPERWORK IS HIGHER FOR FDs
Since you must declare and pay taxes on interest income from FDs every year, you have to maintain records, compute your interest income and file taxes accordingly. This gets even more complicated in the case of premature withdrawals where you may already have paid tax but the income you finally get is lower.
For debt funds, you only have to pay capital gains tax as and when you withdraw. This could mean only once in 5 years.
As you can see, with debt funds, you get superior returns post-tax, high level of liquidity, and safety of capital compared to FDs. These make debt funds an excellent alternative to keeping your money in Bank FDs.
We hope this piece of information was useful to you and next time you seek long term investment in a secured option, be assured that Debt Funds are the perfect resort.
Let us have a look at the Current top 5 performing Debt Funds:
Thus, we can clearly see that on an average, a Debt Fund can provide you best returns with least expected risk.
To know more on investment in Debt Funds as well as to start investments, please feel free to contact us. We at Richvik, would be happy to help you gain the best from your Investments.
Our Contact details are:
Phone: 022-25674106 / 022-25644106
Email ID: email@example.com